22 When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract shall be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the end of the reporting period. An expected loss on the construction contract shall be recognised as an expense immediately in accordance with paragraph 36.
23 In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:
(a) total contract revenue can be measured reliably;
(b) it is probable that the economic benefits associated with the contract will flow to the entity;
(c) both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably; and
(d) the contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates.
24 In the case of a cost plus contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:
(a) it is probable that the economic benefits associated with the contract will flow to the entity; and
(b) the contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably.
25 The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. This method provides useful information on the extent of contract activity and performance during a period.
26 Under the percentage of completion method, contract revenue is recognised as revenue in profit or loss in the reporting periods in which the work is performed. Contract costs are usually recognised as an expense in profit or loss in the reporting periods in which the work to which they relate is performed. However, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 36.
27 A contractor may have incurred contract costs that relate to future activity on the contract. Such contract costs are recognised as an asset provided it is probable that they will be recovered. Such costs represent an amount due from the customer and are often classified as contract work in progress.
28 The outcome of a construction contract can only be estimated reliably when it is probable that the economic benefits associated with the contract will flow to the entity. However, when an uncertainty arises about the collectibility of an amount already included in contract revenue, and already recognised in profit or loss, the uncollectible amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense rather than as an adjustment of the amount of contract revenue.
29 An entity is generally able to make reliable estimates after it has agreed to a contract which establishes:
(a) each party’s enforceable rights regarding the asset to be constructed;
(b) the consideration to be exchanged; and
(c) the manner and terms of settlement.
It is also usually necessary for the entity to have an effective internal financial budgeting and reporting system. The entity reviews and, when necessary, revises the estimates of contract revenue and contract costs as the contract progresses. The need for such revisions does not necessarily indicate that the outcome of the contract cannot be estimated reliably.
30 The stage of completion of a contract may be determined in a variety of ways. The entity uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include:
(a) the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs;
(b) surveys of work performed; or
(c) completion of a physical proportion of the contract work.
Progress payments and advances received from customers often do not reflect the work performed.
31 When the stage of completion is determined by reference to the contract costs incurred to date, only those contract costs that reflect work performed are included in costs incurred to date. Examples of contract costs which are excluded are:
(a) contract costs that relate to future activity on the contract, such as costs of materials that have been delivered to a contract site or set aside for use in a contract but not yet installed, used or applied during contract performance, unless the materials have been made specially for the contract; and
(b) payments made to subcontractors in advance of work performed under the subcontract.
32 When the outcome of a construction contract cannot be estimated reliably:
(a) revenue shall be recognised only to the extent of contract costs incurred that it is probable will be recoverable; and
(b) contract costs shall be recognised as an expense in the period in which they are incurred.
An expected loss on the construction contract shall be recognised as an expense immediately in accordance with paragraph 36.
33 During the early stages of a contract it is often the case that the outcome of the contract cannot be estimated reliably. Nevertheless, it may be probable that the entity will recover the contract costs incurred. Therefore, contract revenue is recognised only to the extent of costs incurred that are expected to be recoverable. As the outcome of the contract cannot be estimated reliably, no profit is recognised. However, even though the outcome of the contract cannot be estimated reliably, it may be probable that total contract costs will exceed total contract revenues. In such cases, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 36.
34 Contract costs that are not probable of being recovered are recognised as an expense immediately. Examples of circumstances in which the recoverability of contract costs incurred may not be probable and in which contract costs may need to be recognised as an expense immediately include contracts:
(a) that are not fully enforceable, that is, their validity is seriously in question;
(b) the completion of which is subject to the outcome of pending litigation or legislation;
(c) relating to properties that are likely to be condemned or expropriated;
(d) where the customer is unable to meet its obligations; or
(e) where the contractor is unable to complete the contract or otherwise meet its obligations under the contract.
35 When the uncertainties that prevented the outcome of the contract being estimated reliably no longer exist, revenue and expenses associated with the construction contract shall be recognised in accordance with paragraph 22 rather than in accordance with paragraph 32.
Part Recognition of Contract Revenue and Expe - AASB 111 - Construction Contracts - July 2004 - Recognition of Contract Revenue and Expenses | Zoe